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Investment banks' quarterly results recap: Rising valuations add some tension

John Shipman | November 08, 2017

Executives across the US investment-banking industry continue to see a compelling landscape for mergers and acquisitions, as an encouraging economic outlook offsets a slowdown in large deals and little clarity on policy matters such as tax reform.

A strong stock market, stable economic growth, low borrowing costs, ample available credit and confident corporate executives are among the factors expected to provide support for M&A, based on a sampling of commentary culled from banks' third-quarter earnings conference calls. 

The setting continues to be called “favorable” and “healthy,” though the issue of extended valuations is having some impact. “Everywhere you go, you definitely hear a recurring theme,” said Navid Mahmoodzadegan, co-president at Moelis & Co., during his firm’s call. Clients considering acquisitions “believe the market is expensive and that high-quality companies are expensive.”

Investment Banks Outlook

This has created a tension between high prices and the demand for M&A, with familiar rationales including the need to better position for technological change, or to “get scale and to get expense savings” in a mediocre-growth environment, he explained.

Disruption from technology “is rippling through just about every sector,” Mahmoodzadegan noted, and “is part of just about every dialogue our bankers are having everywhere,” as companies wrestle with how it will impact their business. “And one of the tools in the toolkit for companies is M&A to better position themselves for the change that’s happening in these industries,” the executive added.

Additionally, there are “record-setting pools of money that have been raised by private equity firms that have to get put to work,” the Moelis CEO pointed out. The “push-pull” between these drivers and the pricey valuations is resulting in “a flattish M&A environment,” he said.

Other executives had similar takes on the market's overall tone. “Global M&A activity remains at slightly lower levels compared to the past few years, particularly for very large transactions,” said Lazard CEO Kenneth Jacobs during his firm’s call in October. “This is, in part, due to continued uncertainty regarding US policy.” Houlihan Lokey Chief Executive Scott Beiser called it “a relatively stable M&A environment, but one that has continued to slightly decline in activity over the last 12 months.”

Those views are in line with observations from Merrill Corporation, which facilitates the sharing and disclosure of financial information, based on data from the deals it supports. Global M&A continued to slow in the third quarter, with legislative gridlock, damaging hurricanes and a quiet September for deals sending North American M&A activity to a five-year low during the period. The energy, mining & utilities sector had the highest transaction value at $78.4 billion.

Corporate tax reform now looms as a potential catalyst for more deal making, but no one is placing any big bets on if or when it might happen. A House Republican plan would cut the top federal corporate rate to 20 percent from 35 percent. Talk of tax code changes “has not had an impact on our deal flow activity or timing of closings,” said Houlihan Lokey's Beiser. It’s also unclear what impact any changes might have either way, he added.

Moelis’s Mahmoodzadegan thinks “meaningful” corporate tax reform – including repatriation of overseas cash and a significant reduction in rates – “could potentially drive incremental M&A business.” At Goldman Sachs, CFO Martin Chavez said clients are keeping an eye on the tax issue, but it’s not stopping them from considering strategic acquisitions or sales right now.

Chavez also said during Goldman’s call that there is “no sense of slowdown” in the firm’s deal pipeline. “We’re seeing a pickup in client dialogue, particularly I would note in technology, media, telecom, as well as industrials and natural resources,” he added.

For J.P. Morgan Chase, Chief Financial Officer Marianne Lake said the market “remains active and the pipeline healthy.” Investment banking revenue grew from the previous quarter, “with particular strength in middle market, which is starting to feel like a trend.”

Bank of America CEO Brian Moynihan also mentioned the middle market in noting a high percentage of the firm’s clients in that segment were taking their investment banking business elsewhere. “So we added middle market investment bankers,” he said.

In commentary from another deal giant, Morgan Stanley CFO Jonathan Pruzan said the firm's transaction pipelines “are healthy and diversified across products regions and sectors.” M&A volumes last quarter were “on par” with year-ago levels, despite a decrease in “larger transformational deals.” Echoing remarks after the prior quarter, Pruzan maintained a cautious outlook, noting “political and policy uncertainties may influence managements’ decision to act.”

About Merrill Corporation

Merrill Corporation helps firms securely protect, share and collaborate on their most sensitive and confidential content. Its industry-leading virtual data room, Merrill DataSite, ensures the right information is shared with the right people, leading to successful mergers and acquisitions. Merrill helps create and file initial public offering documents, as well as periodic financial disclosures required by the U.S. Securities & Exchange Commission.

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